2.3.5—Allocative efficiency

Allocative efficiency occurs when resources produce the combination most valued by society, represented in a competitive model by price equal to marginal cost.

At the efficient quantity, total surplus is maximised under the model assumptions. Market power, externalities and missing markets can cause failure.

Compare marginal benefit and marginal cost, then identify the source of any welfare loss.

If the marginal benefit of the last unit is $5 and marginal cost$5, producing one more would not increase net benefit.

A competitive equilibrium is not automatically socially efficient when external costs exist.